The lease is an operating lease with a 3-year term. Amazon Fleet's 2017 entries include a lease expense of $2,350, reducing the liability by $6,899, and crediting cash for $9,249. For a 1-year term, Amazon Fleet directly credits cash.
Evaluation and Classification:
- Ownership Transfer: No transfer.
- Bargain Purchase Option: None.
- Asset Specialization: Not specialized.
- Lease Term: 3 years.
- Present Value of Payments: Calculate using implicit rate (5%).
This lease is an operating lease as it doesn't meet the criteria for a finance lease.
Amortization Schedules:
- Year 1:
- Lease Payment: $9,249
- Interest Expense (5% on BV): $2,350
- Reduction in Lease Liability: Lease Payment - Interest Expense
- Book Value: Initial Book Value - Reduction in Lease Liability
- Repeat for Years 2 and 3.
2017 Journal Entries for Amazon Fleet:
- Debit Lease Expense: $2,350
- Debit Lease Liability: $6,899 (Lease Payment - Interest Expense)
- Credit Cash: $9,249
2017 Journal Entries for Low Falls:
- Debit Cash: $9,249
- Credit Unearned Lease Revenue: $9,249
Short-Term Lease Option (1 year):
- Debit Lease Expense: $2,350
- Credit Cash: $9,249
These entries represent the initial recognition of lease income and expenses, considering the operating lease nature and payments made by Amazon Fleet to Low Falls.
The complete question is:
Low Falls Corporation entered into a lease agreement on January 1, 2017, to provide Amazon Fleet Company with a piece of machinery. The terms of the lease agreement were as follows.
The lease is to be for 3 years with rental payments of $9,249 to be made at the beginning of each year.
The machinery has a fair value of $61,000, a book value of $47,000, and an economic life of 8 years.
At the end of the lease term, both parties expect the machinery to have a residual value of $40,000, none of which is guaranteed.
The lease does not transfer ownership at the end of the lease term, does not have a bargain purchase option, and the asset is not of a specialized nature.
The implicit rate is 5%, which is known by Amazon Fleet.
Collectibility of the payments is probable.
Instructions
(Round all numbers to the nearest dollar.)
Evaluate the criteria for classification of the lease, and describe the nature of the lease.
Prepare the amortization schedules Amazon Fleet will use over the lease term.
Prepare the 2017 journal entries for Amazon Fleet.
Prepare the 2017 journal entries for Low Falls.
Suppose the lease were only for one year instead of 3 years, with just one lease payment at the beginning of the lease term. Prepare any journal entries Amazon Fleet would need, assuming it elects to use the short-term lease option.